Are You Recession Ready?

If you’re looking for advice on whether winter is coming, you might do no better than an architect. They’re usually among the first to know when an economic downturn is on the way. It’s why forecasters use the Architecture Billings Index, a monthly survey of companies, to help predict what’s coming nine to 12 months out. “Architecture is much more volatile. … We’re a little bit of a canary in the coal mine,” says John Webre, CEO at Dreyfuss + Blackford, who’s been through four recessions in his more than 30-year career.

The March index showed a decline in architecture firm billings for the first time in two years. Among the mixed signals coming from forecasters about whether the economy will hit a pause in the next 18 months, that counts as a yes. Most local experts and industry players think the Capital Region’s economy is a bit better positioned to ride out a downturn than in 2008. But individual companies need to better assess their own ability to do so and make adjustments as needed, say those who stayed afloat through the last storm.

Regional and National Forecasts Are Mixed

For those who lived through it, the Great Recession felt something like a meteorite strike. John Jackson, chairman and CEO of Jackson Properties, saw it up close. His Sacramento company had a building that was two-thirds occupied by a real estate title company. His tenant survived about 18 months but ultimately shuttered. For Jackson, that meant 30,000 square feet of empty space. With title and mortgage companies closing across the region, some commercial property managers suddenly were staring at 70 percent vacancy rates, he says.

The effects of the recession still are being felt in the form of a market overreaction that’s meant a long stretch of lean building years. In 2008, developers built almost 1.5 million square feet of office space in the four-county Sacramento metro area, according to Colliers International. In the more than a decade since, there has been no significant speculative office construction, says Colliers’ Bob Shanahan. That has shrunk the vacancy rate for office space to its lowest point in almost 17 years and pushed office rents up by 4 percent to 5 percent a year, according to a Colliers’ fourth-quarter 2018 analysis.

Recent forecasts have generated headlines about a possible downturn by next year. “Is Sacramento headed toward a recession?” asked the Sacramento Business Review’s January 2019 cover. The report, compiled by a team of financial analysts and researchers, cited slowing employment growth, declining consumer sentiment, and lower revenues and cash flow for area small businesses that the report assessed. Three months earlier, University of the Pacific’s Center for Business and Policy Research projected a growth slowdown in 2020 and 2021, with an increasing risk of a mild recession.

Both groups have backed off those warnings. SBR co-author Chase Armer of financial planning firm Planned Solutions now says the data since January show a decreased short-term likelihood of recession because labor force growth for the region has accelerated. And the newest UOP forecast, released in February, projects growth in Sacramento will be sustained and possibly accelerate in 2019 and 2020.

“It’s not whether there’s going to be a recession — there will be, there always have been. My questions are, ‘What’s it going to look like? How severe will it be? Will it be a shallow one, will it be a big one? And what will trigger it?’” Mark Friedman, president, Fulcrum Property

Some national forecasts are less encouraging. In a survey of a panel of 55 business economists in March, respondents put the odds of a recession by 2019 at 20 percent and by 2020 at 35 percent. In another March survey, this one of 469 CFOs, two-thirds said they believe a U.S. recession will hit by the third quarter of 2020. “That’s really frightening,” says Michael Evans, leadership team member for Northern California at business advisory firm Newport Board Group. “When so many CFOs think that we’re going to be in a recession, it becomes almost a self-fulfilling prophecy.”

The U.S. Treasury market also has emitted ominous signals: two “yield curve inversions,” when short-term interest rates exceed long-term rates, on March 22 and May 9. An inverted yield curve indicates investors may be losing confidence in the economy’s prospects. In a normal market, bonds with shorter maturities should pay out less than those with longer maturities. Inversions act something like lie detectors for the economy: With one exception, they’ve predicted recessions within six months to two years going back to 1955, according to the Federal Reserve Bank of San Francisco. (That one false positive in the mid-’60s was followed by a slowdown but not an official recession.)

Some companies are adjusting accordingly. Evans, who serves on several corporate boards, says planning for a recession is becoming a regular topic of discussion. In real estate, Jackson says his company is hedging its bets — staying liquid, selling assets, preparing for what he thinks is a likely downturn in the next year or two. Mark Friedman, founder and president of Fulcrum Property, points to a disconnect between the cost to build new apartments and what people can afford. When that happens, costs have to come down, meaning a drop in real estate prices. “It’s not whether there’s going to be a recession — there will be, there always have been,” he says. “My questions are, ‘What’s it going to look like? How severe will it be? Will it be a shallow one, will it be a big one? And what will trigger it?’”

Is the Capital Region More Recession-Ready Today?

As dramatic as it sounds to accept recession as fact, it’s no different from acknowledging that sometimes it will rain. Since 1945, U.S. recessions have hit every six years on average.

But most experts think the local economy is a bit better positioned than last time, in large part because it’s not suffering the residential real estate delirium of the

pre-recession years. Single-family building permits for the metro area, which peaked at 22,000 in 2004, were about 8,000 last year. That also means fewer of the ancillary businesses — mortgage servicers, title companies, appraisers, property insurers and so forth — that serviced all that overbuilding. So if a downturn comes, job numbers won’t drop as precipitously as in 2008, when Sacramento’s levels fell more than the national average.

Much of the new construction is commercial, and it’s an attempt to keep up with demand. A lot of that building is accommodating an expanding health care sector that’s also creating employment. Among others, health insurance giant Centene is building a 68-acre campus in North Natomas the company says will create as many as 5,000 new jobs. Medical device manufacturer Penumbra is opening a new office in Roseville and bringing 250 jobs. California Northstate University is proposing to build a teaching hospital in Elk Grove, and Kaiser Permanente is planning a hospital at the Railyards, though no job projections have been announced for those two projects.

The region’s slightly better economic diversification than in 2008 also will help hedge against a downturn, much as a diverse investment portfolio protects individual investors. Data provided by UOP’s Center for Business and Policy Research show that the share of the labor force composed of government workers dropped from about 25 percent in 2008 to less than 24 percent in 2018. Meanwhile, the share employed in health care or social assistance has grown from about 10 percent to almost 15 percent. The numbers in financial services — which includes a lot of real estate professionals — dropped from about 7 percent to 5 percent, while those in professional and business services rose from 12 percent to 14 percent.

The takeaway from those numbers is that without a real estate bubble this time Sacramento is less immediately susceptible to the economy’s ups and downs than other regions. Government and health care always have been less cyclical than areas like technology, trade and manufacturing, says UOP center director Jeffrey Michael. State government is in better shape than before the 2008 recession, when it had essentially no rainy-day fund. Today that fund is about $16 billion, one of the state’s largest surpluses. “Sacramento is certainly not recession-proof, but I don’t believe the next recession will hit here earlier or harder than other regions,” says Michael.

And many of the area’s businesses have become more prudent because of 2008. Companies have less debt now; the pre-recession debt levels were unprecedented, says Curtis Rocca, managing partner at Roseville-based business consulting firm DCA Partners and a member of Comstock’s editorial advisory board. Most commercial bankers he talks to say their clients have deleveraged their balance sheets.

Still, how well the Capital Region and state can ride out a financial quake depends on the magnitude. In early 2009, the state deficit reached a stunning $57 billion, which would wipe out today’s rainy-day fund three times over. And Armer, co-author of the 2019 SBR report, notes that the area has more temporary workers than before the last recession. In layoffs, they’d be the first to go, which could hurt consumer spending.

“If you look at the (Sacramento) landscape, it’s a lot more diversified than where we were in 2007 or earlier.” Sanjay Varshney, chief economist, Sacramento Business Review report

All that points to the need for even more effort to broaden the range of employers in the region. With almost a quarter of workers in state government, any downturn in state spending would mean another big disruption. “If you look at the (Sacramento) landscape, it’s a lot more diversified than where we were in 2007 or earlier,” says Sanjay Varshney, chief economist on the SBR report and a member of Comstock’s editorial advisory board. “But I’m not sure we’re where we need to be to ensure that we don’t go through a bigger crisis again, compared to any national crisis.”

Barry Broome, CEO of the Greater Sacramento Economic Council, argues that state economic policies — high tax rates and development impact fees and complex California Environmental Quality Act regulations — make investors wary and impede efforts to attract diverse businesses. But he also praises the city’s and state’s willingness to invest in luring new business. Sacramento used its 3-year-old, $10-million Innovation and Growth Fund to attract Centene to Natomas by offering $9,000 for every full-time job the company creates that pays 125 percent of the county average wage, up to a maximum of 1,500 jobs. And he points to the Governor’s Office of Business and Economic Development, created in 2013; it helped court Centene with a $7 million tax credit.

How to Recession-Proof Your Business

No regional economy can shield itself from the winds of the national economy, and that goes double for companies. But area experts say firms can minimize the effect of recessions on their bottom lines.

That means assigning someone to read the forecasts and follow key macroeconomic trends. Evans looks for changes in that critical yield curve, and he watches whether investors are moving into safer stocks like food and necessities, which signals they’re nervous. He also looks at sales of new cars and second homes, the first luxuries to go when consumers are pulling back. Friedman discusses trends with his contacts in real estate markets around the country and talks to his commercial retail tenants about their sales trends. Closer to home, shorter delivery times from suppliers may mean their business is slowing, says Bill Slaton of Sacramento management consulting firm Leading Resources Incorporated. And slowdowns in building permits and project starts mean developers sense trouble, he says.

Making the business less vulnerable means cash reserves — advisers often recommend enough to cover three to six months of a company’s expenses. Cash on hand was why Ford made it through the recession but Chrysler and GM didn’t — after it hit, bank loans dried up within three months, says Evans. “You want to be able to get through a recession without having to go back to the banks because the banks could freeze up pretty quickly.”

It also means diversifying your income stream. Slaton looks at the percentage of a company’s business represented by its top five or fewer clients; the higher that number, the more at risk. At Dreyfuss + Blackford, Webre says his company’s three key markets — health care, higher education and government — let them ride out the 2008 recession because when one or two were down, the third was stable or up. His firm has since diversified geographically, opening an office in San Francisco in 2017.

Webre has learned from his rough rides through recessions. “The lesson of this practice is ‘Don’t put all your eggs in one basket,’” he says.

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